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1. Introduction
In this paper, we analyze the value of money. We consider both paper
money and gold. We attempt to relate the supply of money (MS) and gold to
their purchasing power (PP). We demonstrate the extent to which printing of
money dilutes its value. As a store of value, the value of money is
represented by its purchasing power. We compare the ability of paper money
and gold to function as a long-term store of value. We conclude that gold is
an excellent store of value, while paper money is not. We observe that
excessive printing of paper money is the ultimate cause for the inability of
paper money to function appropriately as a store of value.
2. Data Sources
Historical monetary data is readily available on the internet. The
official source is the Federal Reserve Board. Its monetary aggregate data can be found on its web site and is available free
of charge.
The Bureau of Labor Statistics (BLS) publishes the historical Consumer Price Index (CPI) data. Like the Fed, it also publishes the
data on its web site and makes it freely available. For a proxy of the
purchasing power of money, we use the inverse of the consumer price index. To
illustrate, if the price index doubles, the purchasing power is halved; if
the price index increases 10 times, then purchasing power of money falls 90%.
3. The Purchasing Power of the USD
The following chart shows together the data taken from the above two
sources.
The chart visually shows the near-perfect inverse relationship between
the amount of money in circulation and its purchasing power. It reflects the
simple relationship that prices increase approximately proportionately to
money supply. Stated differently, it reflects the basic tenet of monetarism
that in the long-run, price inflation is a direct consequence of increase to
monetary inflation. It also underlies the classical theory of "money
neutrality"; whether one believes that money is "neutral" or
not is a completely different story.
Looking at the data, from January 1971 to December 2008, the U.S.
money supply increased 16.8 times; this was accompanied by an 81.1% drop in
purchasing power of the dollar, as implied by the governmentally-reported
CPI. Thus, the data suggests that a 17-time increase in money supply has
resulted in an approximately five-time fall in purchasing power. We do not
attempt to explain this significant gap, but mention that the gap may be due
to (1) increases in productivity, (2) over-reported money supply, (3)
under-reported CPI, (4) over-valued asset prices (stocks, bonds, real
estate), or possibly (5) a fundamental flaw in the quantity theory of money.
We would suggest, in order of significance, (3), (4), and (1) as the most
important factors explaining the gap.
4. The Purchasing Power of Other Major Currencies
The United States is not alone in pursuing inflationary monetary
policy and steadily inflating its money supply. Available historical exchange
rate and money supply data permit similar analyses for other major
currencies. We provide a similar analysis for (1) the British Pound, (2) the
Canadian Dollar, (3) the Australian Dollar, (4) the Japanese Yen, and (5) the
Swiss Franc for the same period (1971-2008).
We chose 1971 as a starting point for three reasons. First, prior to
1971 exchange rates were fixed, Second, pre-1971 exchange rate data is
difficult to obtain. Finally, prior to 1971 the dollar was fixed
(convertible) to gold. On the other hand, after 1971, exchange rates were
floating, data is available, and the dollar floated against gold.
In other words, we chose the post-Bretton-Woods
period. Bretton Woods is the period that
characterizes the international monetary regime between WWII and 1971. After
the Second World War, only the U.S. Dollar remained convertible to gold at a
rate of US$35 per troy ounce. During that period all other currencies were
linked to the dollar at a fixed exchange rate. On August 15, 1971, President
Nixon unilaterally closed the 'gold window' to prevent foreigners from
exchanging their U.S. Dollars for gold. Thus, he terminated the
convertibility of the dollar to gold and allowed the dollar to float against
gold. This was done likely to prevent the complete loss of the U.S. gold
reserves. In turn, other currencies began to float against the U.S. dollar.
Since that historic moment, for nearly 38 years all currencies in the world
have not been backed by any tangible asset. It is an unprecedented monetary
experiment that extends to the entire world and involves every living person.
The next three charts show similar relationships for the British
Pound, The Canadian Dollar, and the Australian Dollar.
Interestingly enough, the remaining two currencies - the Japanese Yen
and the Swiss Franc - displayed greater resilency
to monetary inflation and depreciation. This is especially true for the Swiss
Franc - the amount of Swiss Francs in circulation increased a relatively
modest 280% over the same period. The explanation may lie in the fact that
even though the Swiss Franc has not been technically (legally) convertible to
gold, the Swiss Central Bank has attempted to maintain proper gold backing of
the Franc, which in turn, had the effect of moderating inflation.
5. The Purchasing Power of Gold
Before 1971, gold was always used as a basis for money. It is
generally accepted that gold has functioned well as a store of value and has
maintained its purchasing power for over 5000 years. So, what can we say
about the supply of gold and its purchasing power for the period of
1971-2008? How does gold compare as a store of value (purchasing power)
against other major currencies for the same period?
For the supply of gold, we use data from the U.S. Geological Survey
(USGS) and the World Gold Council (WGC). USGS maintains records of
supply-demand statistics for a variety of minerals and metals, including gold, going back to 1900. The WGC estimates that a total
of 165,547 tonnes of gold have been mined,
including 2,400 metric tonnes for 2008. Combining
the two data sets, we infer that for the period of 1971-2008, gold supply
increased from 93,515 metric tonnes of gold to
165,948; thus, for the whole period, gold supply increased by merely 78%.
For the same period and using the same CPI statistics, the purchasing
power of gold has actually increased four times. The price of gold is up from
about $38 to about $822, which corresponds to an increase in its price of
almost 22 times, while the CPI is up from about 40 to 210,
or about 5 times. Thus, for the period, the price of gold has increased about
22 times, while the price level has increased about five times, resulting in
an increase in the purchasing power of gold of about four times; the exact
increase is 310%, which corresponds to purchasing power of a little over four
times. The
numbers are shown on the
graph below.
6. Conclusion
So, what can we conclude from this whole analysis? The overall
conclusion is that gold is a significantly better store of value than paper
currencies. While the purchasing power of gold is up
four times, the purchasing power of major currencies is down
5-10 times, except for the Swiss Franc and the Japanese Yen, whose
depreciation is significantly less. The second column in the table below, Change in Unit Value, shows the exact percentages.
|
Supply Fold-Increase
|
Change in Unit Value (%)
|
Gold
|
1.8
|
310.4
|
CHF
|
3.8
|
-23.7
|
JPY
|
15.9
|
-25.4
|
USD
|
16.8
|
-81.1
|
CAD
|
15.4
|
-84.4
|
AUD
|
33.5
|
-88.2
|
GBP
|
12.6
|
-88.3
|
The explanation for gold's ability to hold its purchasing power is
obvious from the first column. While the supply of gold has not even doubled
for the period, the supply of some currencies has increased 10-20-30 times
and more. For example, the supply of Australian dollars increased 33.5 times,
while the supply of Canadian Dollars is up 15.4 times. There should be no
wonder why they have lost most of their value for the period. If governments
print them fast, they will depreciate rapidly - it is as simple as that.
Governments can't print gold, so they can't depreciate its value. In the
world of money, gold is still the best store of value.
Notes
It was illegal for Americans to
own gold for investment purposes since President Roosevelt signed Executive
Order 6102 on April 5, 1933. It wasn't until Dec 31, 1974 when Americans
could once again own gold coins, bars and certificates.
Mike Hewitt
Editor
DollarDaze.org
Mike Hewitt is the
editor of www.DollarDaze.org, a website pertaining to commentary on the instability of the global
fiat monetary system and investment strategies on mining companies.
Disclaimer: The
opinions expressed above are not intended to be taken as investment advice.
It is to be taken as opinion only and I encourage you to complete your own
due diligence when making an investment decision.
© 2007 DollarDaze
Information contained
herein is obtained from sources believed to be reliable, but its accuracy
cannot be guaranteed. It is not intended to constitute individual investment
advice and is not designed to meet your personal financial situation. The
opinions expressed herein are those of the author
and are subject to change without notice. The information herein may become
outdated and there is no obligation to update any such information. The author, 24hGold, entities in which they have an
interest, family and associates may from time to time have positions in the
securities or commodities discussed. No part of this publication can be
reproduced without the written consent of the author.
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